I’ve looked in the past at Japanese growth between the early 90s and 2007, and found something disconcerting: if you assume that the economy was at more or less full employment at either end, and draw a trend line in between, it doesn’t look as if the economy was ever very depressed — which is at odds with all the anecdotal evidence, not to mention the slide into deflation. But there’s a reason for this: Japan’s potential output growth almost surely slowed sharply over that period, as the working-age population first leveled off and then began falling with increasing speed. And this makes straight trend-fitting a very misleading exercise.

Things make a lot more sense if you look at real GDP per working-age Japanese. Here’s a picture using the population 15-64; I present it in logs, so that a constant growth rate would be a linear trend:

I’ve sketched in a linear trend, to indicate what would happen if you believed that potential GDP per working age capita grew at a constant rate.

This picture suggests that the Japanese economy was indeed depressed for about 16 years, and deeply so after the slump of the late 1990s. But it may have returned to more or less potential output on the eve of the current crisis.

Just to be clear, this is not a picture of policy success; it is, in fact, a picture of enormous waste. But the condition wasn’t permanent.

And one more thing: whatever you think of Japan’s adjustment, the Bank of Japan fell down on the job by not taking advantage of the relatively good years from 2002-2007 to break out of deflation. The fact that Japan was still a deflationary economy when the 2008 crisis hit made it much more vulnerable than it should have been.